Management accounting overhead variance

1. A
Project report
on






















ASSAM UNIVERSITY, SILCHAR

MARCH, 2014

2014



Submitted to:
Prof. A. L. Ghose



Submitted by:
Biswajit Bhattacharjee
Batch 2013-2015

“Calculation of Variances (Overheads) and its
Interpretations”

2. LIST OF CONTENTS

Title Page No.


Introduction 1
Variance Analysis 1
Classification 2
Adverse/Negative/Unfavourable Variance 2
Positive/Favourable Variance 2
Types of Variances: 3
Cost Variance 3
Direct Material Cost Variance (DMCV) 3
Direct Labour Cost Variance (DLCV) 3
Overhead Cost Variance (OCV) 4
Overhead Cost Variance 4
Variable Overhead Variances 5
 Variable Overhead Cost Variance 5
 Variable Overhead Expenditure Variance 5
 Variable Overhead Efficiency Variance 8
Fixed Overhead Variance 12
 Fixed Overhead Cost Variance 12
 Fixed Overhead Expenditure Variance 13
 Fixed Overhead Volume Variance 14
 Fixed Overhead Capacity Variance 16
 Fixed Overhead Efficiency Variance 16
 Fixed Overhead Capacity Variance 17
Combined Overhead Variances 19
 Two Variance Method 19
 Three Variance Method 19
 Four Variance Method 20
An Alternative Method of Analysis of Fixed Overhead Variance 25
BIBLIOGRAPHY

3. INTRODUCTION

The success of a business enterprise depends to a greater extent upon how efficiently and
effectively it has controlled its cost. In a broader sense the cost figure may be ascertained and
recorded in the form of Historical costing and predetermined costing. The term Historical costing
refers to ascertainment and recording of actual costs incurred after completion of production.
One of the important objectives of cost accounting is effective cost ascertainment and cost
control. Historical Costing is not an effective method of exercising cost control because it is not
applied according to a planned course of action. And also it does not provide any yardstick that can
be used for evaluating actual performance. Based on the limitations of historical costing it is
essential to know before production begins what the cost should be so that exact reasons for
failure to achieve the target can be identified and the responsibility be fixed. For such an approach
to the identification of reasons to evaluate the performance, suitable measures may be suggested
and taken to correct the deficiencies.


VARIANCE ANALYSIS

Standard Costing guides as a measuring rod to the management for determination of "Variances"
in order to evaluate the production performance. The term "Variances" may be defined as the
difference between Standard Cost and actual cost for each element of cost incurred during a
particular period. The term "Variance Analysis" may be defined as the process of analyzing
variance by subdividing the total variance in such a way that management can assign responsibility
for off-Standard Performance.
The variance may be favourable variance or unfavourable variance. When the actual performance
is better than the Standard, it resents "Favourable Variance." Similarly, where actual performance
is below the standard it is called as "Unfavourable Variance."
Variance analysis helps to fix the responsibility so that management can ascertain -
(a) The amount of the variance
(b) The reasons for the difference between the actual performance and budgeted performance
(c) The person responsible for poor performance
(d) Remedial actions to be taken

4. Classification
» Adverse/Negative/Unfavourable Variance
The variance is said to be either negative (−) or Adverse (Adv) or Unfavourable (Unf) if it indicates a
loss.
 In relation to costs, we would incur a loss if the actual cost is greater than the standard cost.
 In relation to profits or incomes, we would incur a loss if the actual profit or income is less
than the standard.
This type of variance is indicated by either a negative sign (−) placed before the value of the
variance or by writing the letters UF or Unf or Adv after the value.
» Positive/Favourable Variance
The variance is said to be either Positive (+/Pos) or Favourable (Fav) if it indicates a gain position or
beneficial position.
 In relation to costs, we would gain if the actual cost is less than the standard cost.
 In relation to profits or incomes, we would gain if the actual profit or income is greater than
the standard.
This type of variance is indicated by either a positive sign (+) placed before the value of the
variance or by writing the letters Fav or F or Pos after the value.


Variance Formulae » Standard − Actual (Or) Actual − Standard ??

To have a clear understanding the below explanation is given as an aid:
» When measuring Variance in Expenses/Costs
Standard cost is ₹ 2,000 and the actual cost is ₹ 2,400.
This should indicate a negative variance.
How do you get a negative sign? 2,400 − 2,000 or 2,000 − 2,400.
Surely, it would be 2,000 − 2,400
Thus it should be Standard Cost − Actual Cost.
» When measuring Variance in Incomes
Standard income is ₹ 2,500 and the actual income is ₹ 3,000.
This should indicate a positive variance.

5. How do you get a positive sign? 2,500 − 3,000 or 3,000 − 2,500.
Surely, it would be 3,000 − 2,500
Thus it should be Actual Income − Standard Income.



Types of Variances:

Variances may be broadly classified into two categories (A) Cost Variance and (B) Sales Variance. '
(A) Cost Variance
Total Cost Variance is the difference between Standards Cost for the Actual Output and the Actual
Total Cost incurred for manufacturing actual output. The Total Cost Variance Comprises the
following :
I. Direct Material Cost Variance (DMCV)
II. Direct Labour Cost Variance (DLCV)
III. Overhead Cost Variance (OCV)
I. Direct Material Variances:

Direct Material Variances are also termed as Material Cost Variances. The Material Cost Variance is
the difference between the Standard cost of materials for the Actual Output and the Actual Cost of
materials used for producing actual output.
II. Labour Cost Variance (LCV):

Labour Cost Variance is the difference between the Standard Cost of labour allowed for the actual
output achieved and the actual wages paid. It is also termed as Direct Wage Variance or Wage
Variance.
(Here we will be exclusively discussing about the calculation of Overhead Variance and its
interpretations.)


III. OVERHEAD VARIANCE:

6. Overhead may be defined as the aggregate of indirect material cost, indirect labour cost and
indirect expenses. Overhead cost variance can also be defined as the difference between the
standard cost of overhead allowed for the actual output achieved and the actual overhead cost
incurred. In other words, overhead cost variance is under or over absorption of overheads. The
Overhead Cost Variance may be calculated as follows:
Actual Output x Standard Overhead Rate per unit – Actual Overhead Cost (or)
Standard Hours for Actual Output X Standard Overhead Rate per hour – Actual Overhead Cost
Essentials of Certain Terms: For the purpose of measuring various Overhead Variances it is
essential to know certain technical terms related to overheads are given below:
(a) Standard Overhead Rater per unit =
Budgeted Overheads
Budgeted Output


(b) Standard Overhead Rater per hour =
Budgeted Overheads
Budgeted Hours


(c) Standard Output for Actual Time =
Budgeted Output
Budgeted Hours
x Actual Hour

(d) Standard Hours for Actual Output =
Budgeted Hours
Budgeted Output
x Actual Output


Overhead Variances can be classified as:
I. Variable Overhead Variances:
(1) Variable Overhead Cost Variance
(2) Variable Overhead Expenditure Variance or Variable Overhead Budget Variance
(3) Variable Overhead Efficiency Variance
II. Fixed Overhead Variance:
(a) Fixed Overhead Cost Variance
(b) Fixed Overhead Expenditure Variance
(c) Fixed Overhead Volume Variance
(d) Fixed Overhead Capacity Variance
(e) Fixed Overhead Efficiency Variance

7. (f) Fixed Overhead Calendar Variance


I. Variable Overhead Variances:

(1) Variable Overhead Cost Variance:

This is the difference between standard variable overhead for actual production and the actual
variable overhead incurred. The formula is as follows :
Actual Output x Standard Variable Overhead Rate – Actual Variable Overheads
(or) St. Hour for Actual Output x St. Variable Overhead Rate per hour – Actual Variable Overhead


(2) Variable Overhead Expenditure Variance or Variable Overhead Budget Variance:

It is the difference between standard variable overheads allowed for actual hours worked and the
actual variable overhead incurred. This variable may be calculated as follows :
= Actual hours worked x Standard variable overhead rate per hour – Actual variable overhead (or)
Actual hours (Standard Variable Overhead Rate per hour - Actual Variable Overhead Rate per
Hour)
Example

AAA Sports LTD is a small manufacturing company specializing in the production of cricket bats.
AAA Sports LTD currently manufactures 2 types of bats:
AAA Plus - a hand-crafted English Willow bat designed for professional use
AAA Gold - a machine-manufactured cheaper bat designed for casual cricket

Following is a break-up of standard variable manufacturing overhead cost:

AAA Plus AAA Gold
Number of Hours 2 direct labor hours 1 machine hour
Overheads:

8. Indirect Labor ₹ 10 -
Polish ₹ 5 ₹ 1
Sand paper ₹ 1 -
Glue ₹ 1 ₹ 0.5
Machine lubricants - ₹ 0.5
Electricity ₹ 3 ₹ 10

Total ₹20
(₹10 per direct labor hour)
₹12
(₹12 per machine hour)

Following information relates to the actual data from last month:
Variable Manuacturing Overheads ₹ 175,000
Direct Labor Hours 10,000
Machine Hours 5,000

Variable Overhead Spending Variance shall be calculated as follows:

AAA
Plus
AAA
Gold
Total
₹
Actual Variable Overhead Expense

175,000
Less:

Actual Hours 10,000 5,000

Standard Variable O.H. Rate x ₹10 x ₹12

Standard Overhead Expense 100,000 60,000
(160,000)
)
Variable Overhead Expenditure Variance 15,000 Adverse

Analysis

Favorable variable manufacturing overhead spending variance indicates that the company
incurred a lower expense than the standard cost.
Possible reasons for favorable variance include:
 Economies of scale (e.g. increase in order size of indirect material leading to bulk discounts
on purchase)
 A decrease in the general price level of indirect supplies
 More efficient cost control (e.g. optimizing electricity consumption through the installation
of energy efficient equipment)

9.  Planning error (e.g. failing to take into account the learning curve effect which could have
reasonably be expected to result in a more efficient use of indirect materials in the
upcoming period)
An adverse variable manufacturing overhead spending variance suggests that the company
incurred a higher cost than the standard expense.
Potential causes for an adverse variance include:
 A rise in the national minimum wage rate leading to a higher cost of indirect labor
 A decrease in the level of activity not fully offset by a decrease in overheads (e.g. electricity
consumption of machines during set up is usually same even if a smaller batch of output is
required to be produced)
 In efficient cost control (e.g. not optimizing the batch production quantities leading to
higher set up costs)
 Planning error (e.g. failing to take into account the increase in unit rates of electricity
applicable for the level of activity budgeted during a period)

Limitations

Variable production overheads by their nature include costs that cannot be directly attributed to a
specific unit of output unlike direct material and direct labor which vary directly with output.
Variable overheads do however vary with a change in another variable. Traditional management
accounting often define blanket variables such as machine hours or labor hours which seldom
provides a meaningful basis of cost control. The use of activity based costing to calculate overhead
variances can significantly enhance the usefulness of such variances.




(3) Variable Overhead Efficiency Variance:

This variance arises due to the difference between variable overhead recovered from actual
output produced and the standard variable overhead for actual hours worked. The formula is a
follows :
= Standard time for actual production x Standard variable overhead rate per hour – Actual hours
worked x Standard variable overhead rate per hour (or)
Standard Variable Overhead Rate per Hour (Standard Hours for Actual Production – Actual Hours)

10. Example
AAA Sports LTD is a small manufacturing company specializing in the production of cricket bats.
AAA Sports LTD currently manufactures 2 types of bats:
AAA Plus - a hand-crafted English Willow bat designed for professional use
AAA Gold - a machine-manufactured cheaper bat designed for casual cricket
Following is a break-up of the standard variable manufacturing overhead costs:

AAA Plus AAA Gold
Number of Hours 2 direct labor hours 1 machine hour
Overheads:
Indirect Labor ₹ 10 -
Polish ₹ 5 ₹ 1
Sand paper ₹ 1 -
Glue ₹ 1 ₹ 0.5
Machine lubricants - ₹ 0.5
Electricity ₹ 3 ₹ 10
Total ₹20
(₹ 10 per direct labor hour)
₹12
(₹ 12 per machine hour)
Following information relates to the actual data from last month:
Variable Manufacturing Overheads ₹ 175,000
Direct Labor Hours 10,000
Machine Hours 5,000
Production (units) - AAA Plus 4,500
Production (units) - AAA Gold 5,200

Variable Overhead efficiency Variance shall be calculated as follows:

11. AAA
Plus
AAA
Gold
Total
₹
Standard Hours x Standard Rate / hour

Standard Hours (4500x2 / 5200x1) 9,000 5,200

Standard Variable Overhead Rate / hour x ₹ 10 x ₹ 12


90,000 62,400
152,40
0
Less:

Actual Hours x Standard Rate / hour

Actual Hours 10,000 5,000

Standard Variable Overhead Rate / hour x ₹ 10 x ₹ 12


100,000 60,000
152,40
0
Variable Overhead Efficiency Variance 7,600 Adverse


Proof check:
Adding variable overhead spending and efficiency variances to the standard cost should equal to
actual variable overheads during the period.
Standard Cost (Standard hours x Standard rate) = ₹ 152,400 (see above)
Variable overhead spending variance = ₹ 15,000 A (see solution)
Variable overhead efficiency variance = ₹ 7,600 A (see above)
Total = ₹ 175,000

Actual Overheads

₹ 175,000 (from question)

Analysis

12. Favorable variable overhead efficiency variance indicates that fewer manufacturing hours were
expended during the period than the standard hours required for the level of actual output.
Reasons for a favorable variance may include:
 Use of a raw material which is easier to work with (this should be evident in a favorable
material usage variance and possibly an adverse material price variance)
 Employment of a higher skilled labor or improvement of skills of existing workforce through
training and development leading to improved productivity (this should be indicated by a
favorable labor efficiency variance and potentially an adverse labor rate variance)
 Installation of a more efficient manufacturing equipment
 Planning error (e.g. ignoring or under estimating the impact of learning curve effect on
productivity)
An adverse variable overhead efficiency variance suggests that more manufacturing hours were
expended during the period than the standard hours required for the level of actual production.
Possible causes for adverse variance include:
 Use of a cheaper raw material which is harder to work with (this should be corroborated
with an adverse material usage variance and a favorable material price variance)
 Inefficient production caused by the employment of lower skilled labor (this shall be evident
in an adverse direct labor efficiency variance and probably a favorable labor rate variance)
 Decline in the productivity of manufacturing equipment due to for example technical
problems or wear and tear
 Planning error (e.g. over calculating the impact of learning curve effect on the
manufacturing efficiency)

Limitations
Variable Overhead Efficiency Variance is traditionally calculated on the assumption that the
overheads could be expected to vary in proportion to the number of manufacturing hours. While
there is usually correlation between manufacturing hours and variable overheads when
considered on aggregate basis, the number of manufacturing hours may not be the factor that
drives the cost of many types of variable overheads (e.g. setup costs vary with the number of
setups). Using Activity based costing in the calculation of variable overhead variances might
therefore provide more relevant information for management control purposes.
Also, in case where variable overhead rate is based on labor hours, the variable overhead
efficiency variance does not offer any additional information than provided by the labor efficiency
variance.

13. ILLUSTRATION 1: From the following data, calculate variable overhead variance :
Budgeted Actual
Variable overhead ₹ 2,60,000 ₹ 2,50,000
Output in units 20,000 25,000
Working hours 1,10,000 1,25,000
SOLUTION
Standard variable overhead per unit =₹
2,50,000
25,000
= ₹ 10

Standard variable overhead per hour =₹
2,50,000
1,25,000
= ₹ 2

Time allowed per unit of output =
1,25,000
25,000
= 5 hours

Variable Overhead Expenditure Variance
Actual hours worked x Standard variable overhead rate per hour – Actual variable overhead
= 1,10,000 X ₹ 2 - ₹ 2,60,000 = ₹ 40,000 Adverse
Variable Overhead Efficiency Variance
Standard time for actual production x Standard variable overhead rate per hour – Actual hours
worked x Standard variable overhead rate per hour
= 1,00,000 x ₹ 2 – 1,10,000 x ₹ 2 = ₹ 20,000 Adverse
Standard time for actual production = Time allowed for 20,000 units of actual output @ 5 hours
per unit i.e. , 1,00,000 hours.
Total Variable Overhead Variance
Actual output x Standard rate per unit – Actual overhead
20,000 x ₹ 10 - ₹ 2,60,000 = ₹ 60,000 Adverse.

14. II. Fixed Overhead Variance

(a) Fixed Overhead Cost Variance:

It is that portion of overhead cost variance which is due to over absorption or under
absorption of overhead for the actual production. In other words, the variance is the
difference between the standard fixed overheads allowed for the actual production and the
actual fixed overheads incurred. The variance can be calculated as follows:

Actual Output x Stanadard Fixed Overhead Rate per unit – Actual Fixed Overheads
(or)
Standard Hours Produced x Standard Fixed Overhead Rate per Hour – Actual Fixed
Overheads
(Standard Hours Produced = Time which should be taken for actual output i.e. , Standard
Time for Actual Output)
(or)
Fixed Overheads Absorbed – Actual Fixed Overhead




(b) Fixed Overhead Expenditure Variance:

This is otherwise tenned as "Budget Variance." It is the difference between the budgeted fixed
overheads and the actual fixed overheads incurred during the particular period. The formula
for calculation of this Variance is
Expenditure Variance = Budgeted Fixed Overheads – Actual Fixed Overhead
Expenditure Variance = Budgeted Hours x Standard Fixed Overhead Rate per Hours – Actual Fixed
Overheads.
Example
Motors PLC is a manufacturing company specializing in the production of automobiles.
Information relating to its fixed manufacturing overhead expense of last period is as follows:

Rupees

15. ₹
Actual fixed overheads A 526
Budgeted fixed overheads B 500

Fixed Overhead Expenditure Variance A - B 26 Adverse
The variance is adverse since actual expense is higher than the budgeted expense.
Explanation
Fixed Overhead Spending Variance is calculated to illustrate the deviation in fixed production costs
during a period from the budget. The variance is calculated the same way in case of both marginal
and absorption costing systems. As under marginal costing fixed overheads are not absorbed in the
standard cost of a unit of output, fixed overhead expenditure variance is the only variance relating
to fixed overheads calculated under marginal costing (i.e. fixed overhead expenditure variance is
equal to fixed overhead total variance under marginal costing system).
Analysis
Favorable fixed overhead expenditure variance suggests that actual fixed costs incurred during the
period have been lower than budgeted cost.
Reasons for a favorable variance may include:
 Planned business expansion, which was anticipated to cause a stepped increase in fixed
overheads, not being undertaken during the period.
 Cost rationalization measures carried out during the period aimed at reducing fixed overheads
by elimination of inefficiencies (e.g. through process re-engineering and optimization of the
usage of shared resources and facilities).
 Planning inaccuracies (e.g. actual salary raise being lower than anticipated in budget).
Adverse fixed overhead expenditure variance indicates that higher fixed costs were incurred
during the period than planned in the budget.
An adverse variance may be caused by the following:
 Expansion of business undertaken during the period, which was not taken into consideration in
the budget setting process, causing a stepped increase in fixed overheads.

 Inefficient fixed overheads management (e.g. due to empire building pursuits of senior
management).

16.  Planning errors (e.g. increase in insurance premium being higher than budget due to changes in
the risk profile of business).



(c) Fixed Overhead Volume Variance:

This Variance is the difference between the budgeted fixed overheads and the standard fixed
overheads recovered on the actual production. The formula is as follows:

Volume Variance = Actual Output x Standard Rate – Budgeted Fixed Overheads
(or) Standard Rate (Actual Output – Budgeted Output)
(or) Volume Variance = Standard Rate per hour (Standard Hours Produced – Actual Hours)
For example, a company budgets for the allocation of ₹ 25,000 of fixed overhead costs to
produced goods at the rate of ₹ 50 per unit produced, with the expectation that 500 units will be
produced. However, the actual number of units produced is 600, so a total of ₹ 30,000 of fixed
overhead costs are allocated. This creates a fixed overhead volume variance of ₹ 5,000.
The fixed overhead costs that are a part of this variance are usually comprised of only those fixed
costs incurred in the production process. Examples of fixed overhead costs are:
 Factory rent
 Equipment depreciation
 Salaries of production supervisors and support staff
 Insurance on production facilities
 Utilities
Being fixed within a certain range of activity, fixed overhead costs are relatively easy to predict.
Because of the simplicity of prediction, some companies create a fixed overhead allocation rate
that they continue to use throughout the year. This allocation rate is the expected monthly
amount of fixed overhead costs, divided by the number of units produced (or some similar
measure of activity level).
Conversely, if a company is experiencing rapid changes in its production systems, as may be
caused by the introduction of automation, cellular manufacturing, just-in-time systems, and so
forth, it may need to revise the fixed overhead allocation rate much more frequently, perhaps on a
monthly basis.
When the actual amount of the allocation base varies from the amount built into the budgeted
allocation rate, it causes a fixed overhead volume variance. Examples of situations in which this
variance can arise are:

17.  The allocation base is the number of units produced, and sales are seasonal, resulting in
irregular production volumes on a monthly basis. This disparity tends to even out over the
course of a full year.

 The allocation base is the number of direct labor hours, and the company implements new
efficiencies that reduce the actual number of direct labor hours used in production.

 The allocation base is the number of machine hours, but the company then outsources
some aspects of production, which reduces the number of machine hours used.
When the cumulative amount of the variance becomes too large over time, a business should alter
its budgeted allocation rate to bring it more in line with actual volume levels.
Note: If budgeted fixed overhead is greater than standard fixed overhead on actual production,
the variance is unfavourable and vice versa.



(d) Fixed Overhead Capacity Variance:

This is that portion of volume variance which is due to working at higher or lower capacity than the
budgeted capacity. In other words, fixed overhead capacity variance arising due to a particular
cause, i.e., unexpected holidays, breakdown of machinery, strikes, power failure etc. This is
calculated as follows :

Capacity Variance = Standard Rate (Revised Budgeted Units – Budgeted Units)
(or) Capacity Variance = Standard Rate (Revised Budgeted Hours - Budgeted Hour)





(e) Fixed Overhead Efficiency Variance:

18. It is that portion of the Volume Variance which shows the lower or higher output arising from the
efficiency or inefficiency of the workers. This is an outcome of the performance of the workers and
is calculated as :

Standard Rate per unit (Actual Production (in units) – Standard Production (in units))
(or) Standard Rate per hour (Standard Hours Produced – Actual Hours)
Example:
From the following data calculate fixed overhead efficiency variance:
Actual overhead ₹ 7,384
Actual hours worked 3,475
Units produced during the period 850
Standard hours for one unit 4
Standard factory overhead rate:
Variable ₹ 1.20
Fixed ₹ 0.80 ₹ 2.00


Normal Capacity in labor hours 4000 hours
Solution:
3,475 Actual hours worked × ₹ 0.80 fixed overhead rate 2780
3,400 Standard hours allowed × ₹ 0.80 fixed overhead rate 2720


Fixed overhead efficiency variance (unfavorable) ₹ 60 Unfav


When variable overhead efficiency variance and fixed overhead efficiency variance are combined,
they equal the overhead efficiency variance.


(f) Fixed Overhead Calendar Variance:

This is part of Capacity Variance which is due to the difference between the actual number of
working days and the budgeted working days. Calendar Variance can be calculated as follows :

Calendar Variance = Increase or decrease in production due to more or less working days at the
rate of budgeted capacity x Standard rate per unit.

19. Example

Sagar Ltd. provides you the following information:

Budget Actual

Output (Units) 10,000 11,250
Hours 20,000 25,000
Fixed Overheads 50,000 58,000
No. of Working Days 25 26

Calculate Fixed Overhead Calendar Variance.

Solution

Method 1 :-
Step 1: Standard Fixed OH Rate per day
= Budgeted Fixed Overheads / Budgeted No. of Working Days
= 50,000 / 25
= ₹ 2,000 per day

Step 2: Fixed Overhead Calendar Variance
= (Actual No. of Working Days - Budgeted No. of Working Days) X SFOR per day
= (26 - 25) X ₹ 2,000
= ₹ 2,000 (F)

Method 2:-
Step 1: Revised Budgeted Hours (RBH)
= Budgeted Hours / Budgeted No. of Working Days X Actual No. of Working Days
= 20,000 / 25 X 26
= 20,800

20. Step 2: Standard Fixed Overhead Rate per hour (SFOR)
= Budgeted Fixed Overheads / Budgeted Hours
= 50,000 / 20,000
= ₹ 2.5 per hour

Step 3: Fixed Overhead Calendar Variance
= Revised Budgeted Overhead - Original Budgeted Overhead
= (RBH X SFOR) - (BH X SFOR)
= (20,800 X ₹ 2.5) - (20,000 X ₹ 2.5)
= 52,000 - 50,000
= ₹ 2,000 (F)

Note: If the actual days worked are more than the budgeted working days, the variance is
favourable and vice versa.


Combined Overhead Variances

Analysis of overhead variance can also be made by two variance, three variance and four variance
methods.
(a) Two Variance Method and
(b) Three Variance Method &
(c) Four Variance
(a) Two Variance Method: If the Overhead Variances are analysed on the basis of both
expenditure and volume is called as "Two Variance Analysis."
• The two-variance method of overhead analysis breaks down the total variance into a flexible-
budget variance and a production-volume variance.
• Flexible-budget variance measures the amount by which the actual factory overhead costs differ
from the flexible budget for production attained.

21. • The production-volume variance measures difference between the budgeted fixed overhead and
the fixed overhead allocated to work in process
(b) Three-Variance Method
When the volume variance is further analysed to know the reasons of change in output, it is called
three variance analysis. Change in output occurs due to :
(i) Change in capacity i.e., change in working hours per day giving rise to capacity variance.
(ii) Change in number of working days giving rise to calendar variance.
(iii) Change in the level of efficiency resulting into efficiency variance.
Thus, three variance analysis includes :
(i) Expenditure variance
(ii) Volume variance further analysed into :
(a) Capacity variance, (b) Calendar variance, and (c) Efficiency variance.
(c) Four –Variance Analysis includes :
(i) Expenditure Variance or Spending Variance
(ii) Variable Overhead Efficiency Variance
(iii) Fixed Overhead Capacity Variance
(iv) Fixed Overhead Efficiency Variance


ILLUSTRATION 2. From the following data, calculate overhead variance :
Budgeted Actual
Output 15,000 units 16,000 units
Number of Working Days 25 27
Fixed Overheads ₹ 30,000 ₹ 30,500
Variable Overheads ₹ 45,000 ₹ 47,000
There was an increase of 5% capacity.
SOLUTION
(1) Total Overhead Cost Variance

22. Actual units x Standard Rate – Actual Overhead Cost
16,000 units (₹ 2 + ₹ 3) – (₹ 30,500 + ₹ 47,000)
= ₹ 80,000 - ₹ 77,500 = ₹ 2,500 Favourable

Standard Rate =
Standard Overhead
Standard Output


Standard Rate : Fixed : ₹
30,000
15,000
= ₹ 2
- Variable : ₹
45,000
15,000
= ₹ 3
Actual Overhead Cost = Fixed Overhead + Variable Overhead
= ₹ 30,500 + ₹ 47,000 = ₹ 77,500.
(2) Variable Overhead Expenditure Variance
Actual Units x Standard Rate – Actual Variable Overhead Cost
16,000 x ₹ 3 - ₹ 47,000 = ₹ 1,000 Favourable.
(3) Fixed Overhead Variance
Actual Units x Standard Rate (Fixed Overheads) – Actual Fixed Overheads
16,000 x ₹ 2 - ₹ 30,500 = ₹ 1,500 Favourable.
(4) Volume Variance
Actual Units x Standard Rate – Budgeted Fixed Overhead
16,000 x ₹ 2 - ₹ 30,000 = ₹ 2,000 Favourable.
(5) Expenditure Variance
Budgeted Fixed Overhead – Actual Fixed Overheads
= ₹ 30,000 - ₹ 30,500 = ₹ 500 Unfavourable.
(6) Capacity Variance
Standard Rate (Revised Budgeted Units – Budgeted Units)
Budgeted units for 25 days = 15,000 units
Budgeted units for 27 days =
15,000
25
x 27 = 16,200 units

23. Revised budgeted units after 5% increase in capacity
= 17,010 i.e., 16,200 +
5
100
x 16,200
Capacity Variance = ₹ 2 (17,010 – 16,200 = ₹ 1,620 Fav.
(7) Calendar Variance
Increase or decrease in production due to more or less working days x Standard rate per unit
Within 25 days, Standard production = 15,000 units
Within 2 days (27 – 25 ), production will be increased by
=
15,000 x 2
25
= 1,200 Units
Calendar Variance = 1,200 units x ₹ 2 = ₹ 2,400 Favourable.
(8) Efficiency Variance
Standard Rate (Actual Production – Standard Production)
Standard Production
Budgeted Production = 15,000 units
Production increased due to increase in capacity = 810 units
Production increased due to 2 more working days = 1,200 units
-----------------------------------
17,010 units
-----------------------------------
Efficience Variance = ₹ 2 (16,000 units – 17,010 units) = ₹ 2 (-1,010 units)
= ₹ 2,020 Unfavouable


ILLUSTRATION 3. From the following data, calculate overhead variance :
Budgeted Actual
₹ ₹
Overheads 3,75,000 3,77,500

24. Output per man hour in units 2 1.9
Number of Working days 25 27
Man hour per day 5,000 5,500

SOLUTION :
Variances relate to fixed overhead variances, because overheads are to be treated as fixed when
question is silent about their nature whether fixed or variable. We proceed to find out standard
output, standard rate and actual output which are not given in the question :
Standard working days = 25
Standard man hour per day = 5,000
Standard output per man hour = 2
Stanadard output = 25 x 5,000 x 2 = 2,50,000 units
Standard Fixed Overheads = ₹ 3,75,000
Standard Rate per unit = ₹
3,75,000
2,50,000
(
Standard Overheads
Standard Output)
= ₹ 1.50
Actual working days = 27
Actual man hour per day = 5,500
Actual output per man hour = 1.9
Actual output = 27 x 5,500 x 1.9 = 2,82,150 units.
(1) Fixed Overhead Variance
Actual Output x Standard Rate – Actual Overhaeds
2,82,150 x ₹ 1.50 - ₹ 3,77,500 = ₹ 4,23,255 - ₹ 3,77,500 = ₹ 45,725 Favouable.
(2) Expenditure Variance
Budgeted Overheads – Actual Overheads

25. ₹ 3,75,000 - ₹ 3,77,500 = ₹ 2,500 Unfavourable.
(3) Volume Variance
Actual Output x Standard Rate – Budgeted Overhead
2,82,150 units x ₹ 1.50 - ₹ 3,75,000
= ₹ 4,23,225 - ₹ 3,75,000 = ₹ 48,225 Favourable
(4) Capacity Variance
Standard Rate (Revised Budgeted Units – Budgeted Units)
Revised Budgeted Units
Actual Working days = 27
Revised man hours due to increase in capacity = 5,500
Standard Output per man hour = 2
Revised Budget Units = 27 x 5,500 x 2 = 2,97,000 units
Budgeted units = 27 x 5,000 x 2 = 2,70,000 units
Capacity Variance = ₹ 1.50 (2,97,000 – 2,70,000)
= ₹ 40,500 Fav.
(5) Calendar Variance
Within 25 days, budgeted production = 2,50,000 units
Within 2 more working days, production will increase by
=
2,50,000
25
x 2 = 20,000 units
Calendar Variance = 20,000 units x ₹ 1.50 = ₹ 30,000 Fav.
(6) Efficiency Variance
Standard Rate (Actual Production – Standard Production)
Standard Production, i.e., number of units which should have been produced if there had been no
increase or decrease in efficiency.
Budgeted Output = 2,50,000 units

26. Production increased due to increase in capacity = 27,000 units
Production increased due to 2 more working days = 20,000 units
--------------------------
Standard Output 2,97,000 units
---------------------------
Efficiency Variance = ₹ 1.50 (2,82,150 units – 2,97,000 units)
= ₹ 1.50 (- 14,850 units) - ₹ 22,275 Unfav.)


An Alternative Method of Analysis of Fixed Overhead Variance
Some accountants analyse fixed overhead variance into three classifications given below :
(a) Expenditure Variance
(b) Efficiency Variance
(c) Volume Variance
(a) Expenditure Variance. It is that portion of fixed overhead variance which is due to the
difference between the budgeted fixed overhead and the actual fixed overhead incurred during a
particular period.
(b) Efficiency Variance. It is that portion of fixed overhead variance which is due to the
difference between the standard recovery of fixed overhead and the standard fixed overhead for
actual hours. It is calculated as follows :
Standard fixed overhead rate per hour (Standard hours for actual production – Actual hours).
(c) Volume Variance. It is that portion of fixed overhead variance which is due to the difference
between the standard fixed overhead for actual hours and the budgeted hours. It is calculated as
given below :
Standard fixed overhead rate per hour (Actual hours – Budgeted hours)

27. BIBLIOGRAPHY



BOOKS USED

(1) Jain, S.P., & Narang, K.L. (2009). “Cost Accounting Principles & Practice” ; 21
st
edition :
Kalyani Publishers. pp – V/5.33 –V/5.43.

(2) Gupta K. Shashi, & Sharma R.K. (2010). “Management Accounting Theory and Practice” ;
6
th
edition : Kalyani Publishers.

(3) Khan M.K. and Jain P.K, Management Accounting, New Delhi, Tata McGraw Hill (Latest
Edition).






WEBSITES USED
(3) http://en.wikipedia.org/wiki/Variance_%28accounting%29
(4) http://accounting-simplified.com/management/variance-analysis/variable-
overhead/spending.html
(5) http://www.accountingtools.com/variable-overhead-spending-var



*****